Finding the Hidden Insurance Landmines in Oil and Gas Master Service Agreements

By David House from November 16, 2017

We were recently working with an investor who had bought a group of well-servicing contractors throughout the Rockies, North Dakota and West Texas. He knew that there could sometimes be hidden landmines in the contracts that contractors sign to govern their work with well operators. In this case, the contracts were an entire minefield: 80% didn’t have the customary provision specifying that the operator was responsible for an out-of-control well. In other words, if there was a blowout, this small company could be held partially liable for a multimillion-dollar loss with no insurance to cover it. Needless to say, the investor set about reworking all of his contracts.

Contracts for oil and gas projects—known as master service agreements, or MSAs—are meant to streamline operations and avoid lawsuits by clearly specifying what parties are responsible for inevitable accidents and injuries.

Sadly, many MSAs these days are as clear as mud. Some have been sloppily drafted, while others have been modified so many times that they include provisions that don’t apply to the current job.

In a few cases over past years, operators have deliberately attempted to shift more risk to contractors. Meanwhile, many of the standard insurance policies that energy contractors carry assume the MSAs follow certain conventions—for example, knock-for-knock indemnity. Knock-for-knock calls for the contractor to pay for injuries to its employees and damage to its equipment regardless of fault, and the operator takes the responsibility for its own equipment and employees. Another industry standard convention provides that the contractor takes responsibility for aboveground damage (environmental included) to third parties when the contractor is at fault, while the operator is responsible for its equipment and employees, as well as any third-party damages that result from belowground leaks and blowouts.

For energy contractors—and companies buying energy contractors—it is essential to compare terms of all MSAs and insurance policies to find uninsured risks. Depending on circumstance, these gaps can be fixed in one of several ways:

Policies can be modified to cover additional risk without charge if an insurer is notified in writing.

Additional insurance can be purchased or the policy can be changed with a premium increase.

The contract with the operator can be amended or renegotiated to remove the uninsured liability for the contractor.

These solutions may take some work or money, but they’re preferable to a huge bill with no insurance to pay for it. As for the source of such exposure, here’s a list of the most frequent landmines we’ve been finding in MSAs for oil and gas contractors:

Watered Down Knock For Knock. Increasingly, operators are trying to dilute or even eliminate the knock-for-knock provisions of MSAs that often served to protect contractors. We frequently see contracts that hold contractors responsible for damage to an operator’s employees and equipment in cases of gross negligence or willful misconduct. This change raises the specter of legal bills in the event there’s a dispute about who is at fault for an accident, not to mention exposes the contractor to potential liability not covered by its insurance.

Out-Of-Control Wells. Few contracts explicitly hold contractors liable for blowouts; that’s generally meant to be the operator’s responsibility. But some contracts are silent on control of the well, or have ambiguous language that could leave a contractor open to claims. In these cases, the agreement needs to be changed to make clear that the operator takes responsibility for control of the well. Here too, however, we are seeing some operators add provisions that can hold contractors liable for damages from blowouts when the contractor is grossly negligent or causes the problem with willful misconduct. Such a situation might involve an intoxicated employee of a well-servicing contractor who caused a blowout by putting the wrong size blow out preventer on a well. That could make the contractor liable for the costs of bringing the well under control, drilling a new well, cleaning up the debris and remediating the damage, as well as a big legal bill. Out-of-control wells are not covered by standard liability policies available to energy contractors. We see a growing number of contractors choosing to purchase an additional policy, known as contingent operator’s extra expense coverage, so they don’t have to worry about what otherwise could be a very damaging landmine.

Unlimited Liability. Sometimes contractors do small jobs on big projects. If one of these gross negligence provisions or other terms of the MSA could hold the contractor liable for more than its own employees and equipment, it is critical to see if that potential liability has limits. Why? Because your insurance certainly will have limits that could likely be less than the worst-case situation involving a complex project. Here again, the best solution is to negotiate realistic limits into the MSA. If that’s not possible, the next best solution is to secure as much insurance coverage as possible.

Insurance Requirements. It’s not only operators imposing nonstandard provisions; sometimes insurance companies are introducing their own landmines. Many MSAs specify the type of insurance coverage and endorsements each party must maintain, often requiring contractors’ insurance to include several provisions that protect the operator:

Primary and noncontributory. The contractor’s will be the first and only policy to pay claims even when others are at fault.

Waiver of subrogation. A promise by the contractor’s insurance company not to try to seek reimbursement for claims paid from other insurance companies.

Thirty-day notice of cancelation. Protection for the operator from risk when a contractor’s insurance suddenly disappears.

These are common rules and indeed some liability insurance companies automatically include these provisions in cases where the contractor has signed an MSA agreeing to them. Other insurers will agree to these terms, but require written notice. And a few charge an extra premium for this sort of coverage.

Less commonly, MSAs require contractors to secure insurance that isn’t appropriate for the actual risks of the job they are doing. We’ve seen contractors who are performing entirely land-based jobs that were required to have additional insurance covering offshore risk, presumably because the operator had used the same agreement for other offshore projects. Such irrelevant provisions need to be removed from the MSA or clearly marked as not applicable to avoid any situation in which you can be held to be in breach of contract. It’s essential for contractors to work closely with an experienced broker to sweep all of their MSAs for hidden landmines that could potentially leave them liable for multi-million dollar losses.